The Cyclical Behavior of Interest Rates

ABSTRACT

This article investigates the behavior of the term structure of interest rates over the business cycle. In contrast to prior
studies that measure the business cycle by the simple growth in aggregate economic activity, we consider the deviation of
aggregate economic activity from its potentially stochastic trend. We show that incorporating both an independent trend and
cyclical component in consumption improves the efficiency in estimating consumption‐based asset pricing models. We also find
that the term spread is more informative about future changes in stochastically detrended real gross domestic product (GDP)
than future growth rates in real GDP.